T he importance of CG
Corporate governance is the
system by which business
corporations are directed and
controlled with the structure
signifying the sharing of rights and
duties among the unique members in
the corporation. [OECD April 1999]
Why the interest in CG
There has been an increased interest
in corporate governance as a
consequence of events such as the
Exxon Valdez disaster, or the Ford
Pinto scandal sparking debates about
the roles of large corporations in
society and raising questions about
their ethical standards, management
decisions and corporate governance
practices (Kiel and Nicholson, 2003).
The development of corporate
governance systems conventionally
has been in response to corporate
failures or systemic catastrophes. One
of the original failures of governance
was the South Sea Bubble of the
1700s, which revolutionized business
laws and practices in England. The
securities law in the U.S. was
commissioned due to the stock
market crash of 1929, and the
secondary banking crisis of the 1970s
in the United Kingdom and the United
States of America; the savings and
loans debacle of the 1980s are
examples of the responsive nature of
corporate governance.
The history of corporate governance
has been scattered by an arrangement
of well-known company disasters, for
instance, the collapse of the Bank of
Credit and Commerce International,
Barings Bank, Enron, WorldCom, HIH,
OneTel and Parmalat, with each of
these cataclysms being a result of
incompetence, fraud and abuse as
much as from an absence of oversight
rules.
Since Enrons failure in December
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2001, the corporate community and
the authorities internationally have
commenced examining the way
corporations are run from many
perspectives, including:
Board composition and
effectiveness
Executive compensation
Role of the investment banking
community
Stock exchange listing
requirements
Role of the accounting and
auditors professions
Voting patterns of institutional
investors
Islamic Financial Institutions
Ihlas Finance House (IFH) of Turkey,
the largest of the Turkish IIFS, with
over 40% of the sector deposits
collapsed in 2001 after it illegally
misappropriated almost $1billion,
with concentrated ownership and
control allowing an incentive system
biased in favour of shareholders.
(Starr and Yilmaz (2004). The failure of
IFH revealed the risks to the financial
stability and reputation of other
institutions offering Islamic financial
services (IIFS) because of poor
corporate governance, and their
inability to manage liquidity in the
absence of Shariah complaint
secondary markets.
The commitment of concerned
stakeholders to Islamic religious
principles cannot be taken for
granted, and indeed the Islamic
Financial Institutions are no less
disposed to suffering violations of
fiduciary responsibilities. The history
of Islamic finance shows that cases of
corporate governance failures have
features in common with
conventional banking scandals,
including amongst others, collusion of
the board with management, external
and internal audit failures, neglect of
minority shareholders interests,
imprudent lending, and excessive risk
taking by management.
Good corporate governance is crucial
to the ability of a business to protect
the interests of the stakeholders, and
in the case of Islamic institutions
efficiency, stakeholders expect
operations to be carried out in
compliance with the principles of the
Shariah. A corporate structure that
enables an institution to implement
good governance through Shariah-
compliant operations is therefore
fundamental.
Good Islamic corporate governance
principles include honesty, trust,
integrity, openness, performance
orientation, responsibility and
accountability to Allah and the people,
mutual respect, and commitment to
the corporation and all in harmony
with the Islamic Shariah.
Islamic and conventional CG
COMMONLY ACCEPTED PRINCIPLES OF ISLAMIC
CORPORATE GOVERNANCE INCLUDE:
Rights and equitable treatment
of shareholders as per the
Shariah
Interests of other stakeholders,
as dictated by law and according
to the Shariah
Role and responsibilities (of the
board) to Allah and the people
Integrity and ethical behaviour,
in compliance with the Shariah
Disclosure and transparency
Commonly accepted principles of
conventional corporate governance
include:
1. Promoting transparent and
efficient markets steady with the
rule of law
2. Protecting shareholders rights
3. Guaranteeing the equitable
treatment of all shareholders
4. Recognising the rights of
stakeholders recognised by law
5. Timely and accurate disclosure
6. The effective monitoring of the
management by the board
7. The boards accountability
[OECD, 1999]
It is clear that there is an overlap
between these principles, as both
Islamic corporate governance and
conventional corporate governance
are concerned with:
1. shareholder and stakeholder
rights
2. effective disclosure
3. transparency
4. accountability of management
and the board
5. obeying the rule of law
Enhancing stakeholders value is a
central purpose for any business,
including financial services, whether
conventional or Islamic. The stability,
financial performances, and ability to
intermediate resources will depend on
stakeholders confidence in individual
institutions and the industry. A
particular confidence feature in
respect of Islamic financial services is
the requirement of conveying to
stakeholders that their financial
business is conducted in conformity
with their religious beliefs. Corporate
governance arrangements include
structures and procedures that should
provide sufficient comfort that the
business is conducted in accordance
with specified objectives and in
meticulous compliance with Shariah.
The need for Islamic Financial
Institutions to get their house in order
and implement good corporate
governance practices, that are in line
with recognized and expected
business practice as well as being
compatible with the Shariah are
imperative. The key word being
implement practices and not just pay
lip service to the principle.
Peculiarities to IFI
Over the past decade, the world has
seen a significant change in the role of
the private sector in economic
progress and job creation. As more
and more countries have assumed
market-based approaches to
economic policy, mindfulness of the
status of private corporations for the
welfare of individuals has improved.
Corporations create jobs, generate tax
income, produce a wide selection of
goods and services at sensible prices,
and progressively manage our savings
and secure our retirement income.
Amid growing reliance worldwide on
the private sector, the issue of
corporate governance has likewise
increased in importance (OECD
Principles of Corporate governance,
2004).
Islamic finance from the position of
corporate governance represents an
array of fascinating features, as equity
participation, risk and profit-and-loss
sharing measures form the basis of
Islamic financing. The ban on interest
means that an Islamic bank cannot
charge any fixed return in advance,
they, however partake in the profit
from the usage of the funds. The
depositors also share in the profits
according to a pre-set ratio, and are
remunerated with profit earnings for
assuming the risk.
An Islamic bank is a partner with the
banks depositors and the
entrepreneurs and these financial
arrangements infer rather diverse
stakeholder relations, and therefore
governance structures, as depositors
have a direct financial stake in the
bank's investment and equity
participations. This leads to rather
diverse governance issues that Islamic
banks and financial institutions face as
compared to conventional
institutions. The Islamic financial
institution is subject to an added tier
of governance, compliant with Islamic
law.
The Shariah Supervisory
Board
The most common approach at
present is to establish independent
Shariah Supervisory Boards (SSBs), in-
house religious advisers and Shariah
review units.
The role of the Shariah Supervisory
Board includes:
1. Certifying permitted financial
instruments through fatawa
2. Verifying that transactions
comply with issued fatawa
3. Calculating and paying Zakat
4. Disposing of non-Shariah
compliant earnings
5. Advising on the distribution of
income or expenses among
shareholders and Investment
Account Holders (IAH)
A Shariah Supervisory Boards
responsibilities will differ according to
provisions specified in the articles of
association of the financial institution
or those specified by national
regulators. In addition to internal
corporate arrangements, national
regulators and international standard
setters implement guidelines for
Shariah Supervisory Boards. These
guidelines frequently refer to Shariah
Supervisory Boards general
responsibility to guarantee Shariah
compliance and also at times indicate
areas of competence, composition
and decision-making.
The functioning of Shariah
Supervisory Boards raises
five main issues of corporate
governance:
(i) Independence
The Shariah Supervisory Board
members dual relationship with the
institution as providers of
remunerated services and as
assessors of the nature of operations
could be seen as creating a possible
conflict of interest.
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(ii) Confidentiality
Some Shariah scholars sit on the
Shariah Supervisory Boards of more
than one financial institution, this
provides the particular individual
access to proprietary information of
other possibly competing institutions.
(iii) Competence
Shariah Supervisory Board (SSB)
members should ideally be
knowledgeable in both Islamic law
and commercial and accounting
practices. In reality, it would appear
that very few scholars are well versed
in both disciplines.
(iv) Consistency
The activities of Shariah Supervisory
Boards (SSBs) are in the nature of
creating jurisprudence by the
interpretation of legal sources. It
should therefore not be surprising to
find conflicting opinions on the
admissibility of specific financial
instruments or transactions.
(v) Disclosure/Transparency
A transparent financial institution
would ideally disclose the duties,
decision-making process, areas of
competence, and the composition of
the Shariah Supervisory Board, as well
as publish all fatawa issued by the
Shariah Supervisory Board.
The Islamic Viewpoint
The problem is that corporate
governance is inadequate in Islamic
Financial Institutions, and researchers
believe that this is due to the entire
approach regarding the subject. Many
Corporate governance structures have
been put forward, implemented,
along with principles and codes of
behaviour. The importance of
corporate governance in enhancing
stakeholder value, as well as positive
effects towards the organisation have
been spoken and written about by
many researchers and scholars.
However, there is still something
missing, there is a piece of the puzzle
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that is still not in place. The author
believes that it is the fundamental
view of corporate governance and the
importance of it that is missing. The
author postulates that corporate
governance is a duty on every Muslim,
as is prayer, hajj and other such duties
incumbent on every Muslim.
Therefore, the application of it is not a
matter of choice, and nor should it be
looked at from the benefits of doing
so, although these are important, but
rather should be considered at from
the angle of being an obligation.
Therefore, the application of
corporate governance procedures is a
form of worship, and also a duty for
which a Muslim will be held
accountable. He / she will be
rewarded for their application and
held accountable for neglecting them
or inadequate application.
It is not enough to assume that just
because someone is a Muslim, and by
that very nature is expected to obey
the Shariah, that he / she will ensure
that they do not do anything that will
be against the Shariah in terms of
corporate governance duties.
Although, in theory there is a
mechanism of self-accountability,
honesty, trust and therefore should be
self-regulatory, the fact of the matter
is that, this is just not the case, and a
vigilant eye is necessary.
One day Prophet Muhammad (peace
be upon him) noticed a Bedouin
leaving his camel without tying it and
he asked the Bedouin,
"Why don't you tie down your camel?"
The Bedouin replied:
"I put my trust in Allah."
The Prophet then said:
"Tie your camel first, then put your
trust in Allah"
[At-Tirmidhi Hadith No: 2517]
This refers to the common sense and
reasoning that Allah in His Infinite
Mercy has bestowed upon the human
intellect, so that we are able to take
due precautions, plan and prepare for
possible future events, and create a
means of addressing those needs on
our own. Therefore, preventative and
preparative actions are necessary in
all walks of life, and especially
business. The need for regulation to
ensure accountability is necessary,
and not just relying on self-regulation
due to the people following the
Shariah of their own accord.
Therefore, corporate governance is
not a matter of choice or a matter of
good practice or a way to ensure that
you are following the laws of the land.
Corporate governance in Islamic
finance is a duty upon everyone who
pronounces the Shahadah, just as
Salaat is a duty upon the person. This
approach is what will remove the
problems of corporate governance in
Islamic finance institutions. When
people understand, it is a duty upon
them and that Allah (SWT) will hold
the accountable for this duty, then a
change will follow.
www.bcif.co.uk
https://www.facebook.com/bcif.co.uk/
Arshad Ashraf
Researcher & lecturer
in Islamic Finance